June 25, 2009

Economist's View - 5 new articles

Inflation - the real threat to sustained recovery, by Alan Greenspan, Commentary, Financial Times: The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen. Previously capital-strapped companies have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged.

Is this the beginning of a prolonged economic recovery or a false dawn? There are credible arguments on both sides of the issue. ...[T]he crisis will end when ...[there is] a stabilisation of home prices or a further rise in newly created equity value available to US financial intermediaries...

Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment. Leverage would be materially reduced. A prolonged recovery in global equity prices would thus assist in the lifting of the deflationary forces that still hover over the global economy.

I recognise that I accord a much larger economic role to equity prices than is the conventional wisdom. From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets. ...

Stock prices, to be sure, are affected by the usual economic gyrations. But ... a significant driver of stock prices is the innate human propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major causes of it. ...

He also gives his view of the future inflation threat. I'll just note that I quite agree with Greenspan's assertion that he accords "a much larger economic role to equity prices than is the conventional wisdom."

Ben S. Bernanke ... will be grilled on Thursday by the House Oversight and Government Reform Committee about his role in orchestrating Bank of America's controversial takeover of Merrill Lynch late last year.

The House investigation is heavily colored by partisanship. President Obama is proposing to give the Federal Reserve formidable new powers to regulate giant institutions, including Bank of America, that could pose risks to the financial system.

Republicans, along with some Democrats, argue that the Fed already has too much power.

Unhappy about the huge bank bailouts that the Fed arranged with the Treasury Department during the Bush administration, many Republicans are even more displeased that Mr. Bernanke is now working hand-in-glove with the Obama administration.

The result is a set of dueling narratives and agendas, all of which will be on full display when Mr. Bernanke testifies on Thursday. ...

Despite Mr. Bernanke's Republican roots, and the fact that President Bush nominated him to be Fed chairman, the Republican memo prepared for the hearing on Thursday describes Mr. Bernanke as a champion of government intrusion and an ally of President Obama. ...

I don't think this is an attempt to negatively influence Obama's decision on Bernanke's reappointment as Fed chair as some have been hinting because that would not be in the GOP's best interest. There are open positions on the Federal Reserve Board, so even if Bernanke didn't resign as is customary in the event he was not reappointed - and nothing says he must - Obama would still be free to appoint a new Fed Chair from outside the present Board membership.

Obama would certainly appoint someone who shares his regulatory vision, and that person would likely be confirmed (e.g. someone like Janet Yellen would likely be confirmed even if there was lots of grumbling), so I don't see how the appointment of a new Fed chair would do anything but strengthen the support for the type of regulatory oversight the administration envisions. That's not what the GOP wants.

Instead, this looks much more like an attempt to by the GOP to maintain its usual anti-regulatory, anti-government stance by arguing that the Fed should not to be trusted with the powers envisioned in the proposed regulatory reform legislation. So the real goal is the Fed as an institution, Bernanke is simply the target being used to make that the point. E.g.:

The vast extent of the Fed's actions in the past two years to commit trillions of dollars in government money to support the economy has raised significant concerns on Capitol Hill, some of which will be aired on Thursday when Bernanke testifies before the House Committee on Oversight and Government Reform.

Congressional investigators have been looking into the Fed's role in encouraging Bank of America to purchase Merrill Lynch... Rep. Darrell Issa (R-Calif.), ranking member on the Oversight Committee, said on Wednesday that the Fed engaged in a "cover-up" and hid details about the merger, completed in January 2009, from other federal agencies.

Meanwhile, lawmakers from both parties are raising questions about Obama's proposal to grant the Fed broad new powers to prevent another crisis.

Those concerns could make the next confirmation process far more contentious than the six that have occurred in the last two decades.

And:

Sen. Jim DeMint (R-S.C.) said, "It won't be my decision whether he is held over or not, but right now I'm concerned that they have lost their independence and are too cozy with Treasury."

It looks like we are going to get some version of a strategy that has the GOP saying that given what happened to the financial system, of course we need more oversight and regulation of the financial system. But any particular piece of legislation that is proposed will be fought tooth and nail by the GOP as being far too intrusive, granting the government too much power, and generally going far beyond what is needed to solve the problem. The fact that the will for reform will diminish with time works in their favor, and if they can string things out long enough with this strategy, the result will be that the legislation eventually passes in a much weaker form, or it won't ever pass at all.

The Republicans, with a few possible exceptions, have decided to do all they can to make the Obama administration a failure. Their role in the financial regulation debate is purely that of spoilers who keep shouting the old slogan — Government is always the problem, never the solution! — hoping that someone still cares.

As a follow up to the post Don't "Nullify" Fiscal Policy which was part of the Romer Roundtable on fiscal policy mistakes during the Great Depression, in particular the mistake made in 1937 of giving into pressure to balance the budget before the economy had recovered sufficiently causing an economy showing signs of recovery to fall back into depression, David Cay Johnston emails this explanation of the need for deficit spending after large negative shocks from his February 18, 2009 "Johnston's Take" column at Tax Notes:

In the long run we need more savings and investment, but as Keynes famously noted, in the long run we are all dead. What we need right now is money in people's pockets to pay for mortgages so more houses do not fall into foreclosure and employers stop eliminating jobs at an accelerating pace, a rate of nearly 10,000 per day last year and 20,000 per day last month.

Borrowing our way out of this is not without risk. But imagine for a moment that you just got married, bought a house, and are expecting a baby, and your cars unexpectedly broke down. Do you take on more debt by leasing or borrowing for two new cars so you can keep getting to work to pay for the mortgage and the baby crib, or do you shun new debt because it is more prudent to do so?

A report released ... by the European Union found that some 1.9 million jobs were lost in the first quarter, the worst drop since figures were first collected starting in 1995. The unemployment rate was 8.6 percent in April, up from 6.8 percent a year earlier.

But analysts and labor experts say the figures would have been even starker without some of the job-saving measures used to combat the worst recession in decades. ...

Many countries have short-time compensation programs, tailored for the manufacturing sector, under which employers can apply for temporary assistance to lift the wages of workers working reduced hours.

France has a publicly financed partial unemployment plan, allowing companies experiencing difficulties to temporarily lay off workers and draw on state money to pay them during those periods. ... In the Netherlands,... companies ... use... a similar program...

Germany also has several measures to reduce working time, many of which are specifically framed as employment-saving measures. ... German unions have also shown some flexibility. ...

In France, as in other European countries, employers are not normally allowed to lower contracted salaries without employee consent.

But if a business with operations in France has "serious grounds" to think that its economic viability is in danger, and employees refuse a reduced salary, then a company could proceed to layoffs.

To avoid this kind of situation, some companies have tried to negotiate salary reductions. The auto rental company Hertz ... asked French management ... to swallow a pay cut of around 5 percent over three months, without offsetting time off. Slightly more than two-thirds of the 150 managers offered the deal agreed... Hewlett-Packard ... confirmed that it was engaged in similar negotiations to cut the salaries ... ranging from 2.5 to 15 percent.

The Finnish carrier Finnair announced in December plans to temporarily lay off 1,700 cabin crew members on a staggered basis this year to cut costs. The layoffs will last two to three weeks a worker.